The noodle market in Shanghai is perfectly competitive. Mary owns one of the 1,0
ID: 1192429 • Letter: T
Question
The noodle market in Shanghai is perfectly competitive. Mary owns one of the 1,000 noodle restaurants in Shanghai. Each restaurant can serve up to 1000 bowls of noodle per day. Currently, each restaurant serves 100 bowls of noodle per day at $5/bowl. Mary knows she can develop a new sauce (the costs of making the new sauce will be the same as that of making the current sauce). The new sauce will be so tasty that all of the 100,000 noodle eaters in Shanghai would like to buy her noodle at $10/bowl. There are two problems: developing the new sauce's recipe will incur an experimental cost; and all her competitors can figure out the new sauce's recipe after one day the new sauce appears on the market. What is the highest experimental cost that Mary is willing to pay for developing the new sauce?
Explanation / Answer
A rational individual will take up reasearch and development to increase sales if the profit from sales is greater than or equal to the cost of R&D.
In this case the firm that will invent a new product is expected to gain a monopoly power through R&D. The new product will cost the firm as the same as their competitive alternatives. Therefore, once the sauce is prepared and sold each of the 100,000 noodle eaters will buy that at $10 a plate.As the resaurant can sell only 1000 plates In one day, it will increase the profit of the firm by ($10-$5)*1000= $5000 in one day. As the other firm will replicate the recipe within a day, the increased sale will stay for a day. Then the firm will be willing to pay maximum $5000 for this R&D.
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